Business Strategy Cintas helps more than one million businesses of all types and sizes, primarily in theU.S. , as well asCanada ,Latin America ,Europe andAsia , get READY™ to open their doors with confidence every day by providing a wide range of products and services that enhance our customers' image and help keep their facilities and employees clean, safe and looking their best. With products and services including uniforms, mats, mops, restroom supplies, first aid and safety products, fire extinguishers and testing, and training and compliance courses, Cintas helps customers get Ready for the Workday®. We areNorth America's leading provider of corporate identity uniforms through rental and sales programs, as well as a significant provider of related business services, including entrance mats, restroom cleaning services and supplies, carpet and tile cleaning services, first aid and safety services and fire protection products and services. Cintas' principal objective is "to exceed customers' expectations in order to maximize the long-term value of Cintas for shareholders and working partners," and it provides the framework and focus for Cintas' business strategy. This strategy is to achieve revenue growth for all our products and services by increasing our penetration at existing customers and by broadening our customer base to include business segments to which we have not historically served. We will also continue to identify additional product and service opportunities for our current and future customers. To pursue the strategy of increasing penetration, we have a highly talented and diverse team of service professionals visiting our customers on a regular basis. This frequent contact with our customers enables us to develop close personal relationships. The combination of our distribution system and these strong customer relationships provides a platform from which we launch additional products and services. We pursue the strategy of broadening our customer base in several ways. Cintas has a national sales organization introducing all our products and services to prospects in all business segments. Our broad range of products and services allows our sales organization to consider any type of business a prospect. We also broaden our customer base through geographic expansion, especially in our first aid and safety and fire protection businesses. Finally, we evaluate strategic acquisitions as opportunities arise. Results of Operations This Management's Discussion and Analysis of Financial Condition and Results of Operations focuses on discussion of fiscal 2020 results compared to 2019 results. For discussion of fiscal 2019 results compared to fiscal 2018 results, see the "Management's Discussion and Analysis of Financial Condition and Results of Operations" within our Annual Report on Form 10-K for the fiscal year endedMay 31, 2019 , filed with theSEC onJuly 26, 2019 . Cintas classifies its business into two reportable operating segments and places the remainder of its operating segments in an All Other category. Cintas' two reportable operating segments are the Uniform Rental and Facility Services operating segment and the First Aid and Safety Services operating segment. The Uniform Rental and Facility Services reportable operating segment, consists of the rental and servicing of uniforms and other garments including flame resistant clothing, mats, mops and shop towels and other ancillary items. In addition to these rental items, restroom cleaning services and supplies, carpet and tile cleaning services and the sale of items from our catalogs to our customers on route are included within this reportable operating segment. The First Aid and Safety Services reportable operating segment consists of first aid and safety products and services. The remainder of Cintas' business, which consists of Fire Protection Services operating segment and the Uniform Direct Sale operating segment, is included in All Other. These operating segments consist of fire protection products and services and the direct sale of uniforms and related items. Cintas evaluates operating segment performance based on revenue and income before income taxes. Revenue and income before income taxes for each of these reportable operating segments for the years ended May 31, 2020, 2019 and 2018 are presented in Note 14 entitled Operating Segment Information of " Notes to Consolidated Financial Statements ." The Company regularly reviews its operating segments for reporting purposes based on the information its chief operating decision maker regularly reviews for purposes of allocating resources and assessing performance and makes changes when appropriate.
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InMarch 2020 , theWorld Health Organization characterized a novel strain of coronavirus (COVID-19) as a pandemic. Through the first three quarters of fiscal 2020, the COVID-19 pandemic did not have a significant impact on our business. However, efforts to contain the spread of COVID-19 intensified during our fiscal 2020 fourth quarter. Most states and municipalities within theU.S. enacted temporary closures of businesses, issued quarantine orders and took other restrictive measures in response to the COVID-19 pandemic. Within theU.S. , our business was designated an essential business, which allowed us to continue to serve customers that remained open. We have operations throughout theU.S. and participate in a global supply chain. During the fourth quarter of fiscal 2020, the existence of the COVID-19 pandemic, the fear associated with the COVID-19 pandemic and the reactions of governments around the world in response to the COVID-19 pandemic to regulate the flow of labor and products and impede the business of our customers, impacted our ability to conduct normal business operations, which had an adverse effect on our business. In response to the impact of COVID-19, Cintas put in place health and safety measures to keep Cintas employees, contractors and customers safe. These health and safety measures have not materially impacted our ability to service our customers. Many of Cintas' customers were also impacted by COVID-19 and we did see an impact on some customer's ability to pay. While there was minimal disruption to our supply chain, Cintas did experience an increase in inventory caused by the impact of COVID-19. See Note 1 entitled Significant Accounting Policies of " Notes to Consolidated Financial Statements " for additional detail on steps taken to assess the higher collection risk related to our customers and the additional reserve placed on inventory. Cintas also initiated certain activities to reduce operating costs and better align its workforce with the needs of its ongoing business. During the fourth quarter of fiscal 2020, Cintas recorded$24.5 million in employee termination costs and$9.2 million in long-lived asset impairment costs. See N ote 1 entitled Significant Accounting Policies of " Notes to Consolidated Financial Statements ." The impact of the COVID-19 pandemic is fluid and continues to evolve, and therefore, we cannot predict the extent to which our business, consolidated results of operations, consolidated financial condition or liquidity will ultimately be impacted.
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The following table sets forth certain consolidated statements of income data as a percent of revenue by reportable operating segment, All Other and in total for the fiscal years endedMay 31 : 2020 2019
2018
Revenue:
Uniform Rental and Facility Services 79.7% 80.6% 81.0% First Aid and Safety Services 10.0% 9.0% 8.7% All Other 10.3% 10.4% 10.3% Total revenue 100.0% 100.0% 100.0% Cost of sales: Uniform Rental and Facility Services 54.1% 54.5% 55.0% First Aid and Safety Services 52.2% 52.0% 52.9% All Other 58.2% 57.4% 57.5% Total cost of sales 54.4% 54.6% 55.1% Gross margin: Uniform Rental and Facility Services 45.9% 45.5% 45.0% First Aid and Safety Services 47.8% 48.0% 47.1% All Other 41.8% 42.6% 42.5% Total gross margin 45.6% 45.4% 44.9% Selling and administrative expenses: Uniform Rental and Facility Services 28.1% 27.6% 28.6% First Aid and Safety Services 32.7% 33.4% 33.7% All Other 34.9% 33.3% 33.9% Total selling and administrative expenses 29.2% 28.7%
29.6%
G&K Services, Inc. integration expenses -% 0.2%
0.6%
Gain on sale of a cost method investment -% 1.0% -% Interest expense, net 1.5% 1.5% 1.7%
Income from continuing operations before income taxes 14.9% 16.0%
13.0% 18
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Fiscal 2020 Compared to Fiscal 2019 Fiscal 2020 total revenue was$7.1 billion , an increase of 2.8% over the prior fiscal year. Revenue increased organically by 3.1% as a result of increased sales volume. Organic growth adjusts for the impact of acquisitions, foreign currency exchange rate fluctuations and workday differences. Total revenue was positively impacted by 0.2% due to acquisitions, negatively impacted by 0.1% due to foreign currency exchange rate fluctuations and negatively impacted by 0.4% due to one less workday in fiscal 2020 compared to fiscal 2019. As previously discussed, the government enactment of temporary closures of certain businesses in response to COVID-19 impacted our ability to service some of our customers during the fourth quarter of fiscal 2020. As a result, revenue in the fourth quarter was negatively impacted by COVID-19. Due to the constantly changing impact of COVID-19, uncertainty remains about the pace of the economic recovery and about its impact on future Cintas consolidated financial results.
Organic growth by quarter for fiscal 2020 is as follows:
Organic Growth First quarter endedAugust 31, 2019 8.3%
Second quarter ended
-8.4%
For the fiscal year ended
Uniform Rental and Facility Services reportable operating segment revenue consists predominantly of revenue derived from the rental of corporate identity uniforms and other garments, including flame resistant clothing, and the rental and/or sale of mats, mops, shop towels, restroom supplies and other rental services. Revenue from the Uniform Rental and Facility Services reportable operating segment increased 1.6% compared to fiscal 2019 due to an organic growth increase of 2.0%. Revenue growth was positively impacted by 0.1% due to acquisitions, negatively impacted by 0.1% due to foreign currency exchange rate fluctuations and negatively impacted by 0.4% due to one less workday in fiscal 2020 compared to fiscal 2019. Revenue growth was a result of new business, the penetration of additional products and services into existing customers and price increases, partially offset by lost business. New business growth resulted from an increase in the number and productivity of sales representatives. Generally, sales productivity improvements are due to increased tenure and improved training, which produce a higher number of products and services sold. Other revenue, consisting of revenue from the First Aid and Safety Services reportable operating segment and All Other, increased 7.6% compared to fiscal 2019. Revenue increased organically by 7.5% primarily due to improved sales representative productivity and the increased sales of personal protective equipment, offset by a decrease in sales related to customers in All Other as a result of the impact from COVID-19. Revenue growth was positively impacted by 0.5% due to acquisitions and negatively impacted by 0.4% due to one less workday in fiscal 2020 compared to fiscal 2019. Cost of uniform rental and facility services increased 0.9% compared to fiscal 2019. Cost of uniform rental and facility services consists primarily of production expenses, delivery expenses and the amortization of in service inventory, including uniforms, mats, shop towels and other ancillary items. The cost of uniform rental and facility services increase compared to fiscal 2019 was due to increased Uniform Rental and Facility Services reportable operating segment sales volume from organic growth, partially offset by fewer inventory purchases and a reduced amount of inventory put in service during the fourth quarter of fiscal 2020. Cost of other consists primarily of cost of goods sold (predominantly first aid and safety products, uniforms and fire protection products), delivery expenses and distribution expenses in the First Aid and Safety Services reportable operating segment and All Other. Cost of other increased 8.2% in fiscal 2020 compared to fiscal 2019. The increase was primarily related to the increased sales volumes in the First Aid and Safety Services reportable operating segment and an increase in the proportion of sales from personal protective equipment. Selling and administrative expenses increased$90.4 million , or 4.6%, compared to fiscal 2019, primarily due to increases in labor and other employee-partner related expenses. In addition, as previously discussed, Cintas
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initiated certain activities to reduce operating costs and better align its workforce with the needs of its ongoing business. During the fourth quarter of fiscal 2020, Cintas recorded$24.5 million in employee termination costs and$9.2 million in long-lived asset impairment costs. Operating income in fiscal 2019 was negatively impacted by$14.4 million of integration expenses incurred in connection with theG&K Services, Inc. (G&K) acquisition. The after-tax effect of these integration expenses represents a negative impact on diluted earnings per share of$0.10 per share in fiscal 2019. No material integration expenses were recorded in fiscal 2020.
During fiscal 2019, Cintas sold a cost method investment for
Net interest expense (interest expense less interest income) was$104.4 million in fiscal 2020 compared to$100.5 million in fiscal 2019. The increase in interest expense in fiscal 2020 was due to the timing of interest being incurred on our term loan in the current year (twelve months as opposed to one month in fiscal 2019), partially offset by lower commercial paper borrowings in fiscal 2020 compared to fiscal 2019. Income before income taxes was$1,058.3 million , a decrease of$44.1 million , or 4.0%, compared to fiscal 2019. The decrease in income before income taxes was primarily due to the negative impact of COVID-19, as previously discussed, as well as the fiscal 2019 one-time gain on sale of a cost method investment. Cintas' effective tax rate on continuing operations was 17.2% for fiscal 2020 compared to 19.9% in fiscal 2019. The effective tax rate in both periods was impacted by certain permanent differences (primarily the tax accounting for stock-based compensation). Net income from continuing operations for fiscal 2020 of$876.4 million was a 0.7% decrease compared to fiscal 2019. Diluted earnings per share from continuing operations of$8.11 was a 1.8% increase compared to fiscal 2019 diluted earnings per share from continuing operations of$7.97 . Diluted earnings per share from continuing operations increased primarily due to the positive impact from the lower diluted weighted average common shares outstanding during fiscal 2020. Uniform Rental and Facility Services Reportable Operating Segment Uniform Rental and Facility Services reportable operating segment revenue increased$91.1 million , or 1.6%, and the cost of uniform rental and facility services increased$27.5 million , or 0.9%, due to the reasons previously discussed. The reportable operating segment's fiscal 2020 gross margin was 45.9% of revenue compared to 45.5% in fiscal 2019. The increase in gross margin was driven by new business sold by sales representatives, penetration of additional products and services into existing customers and continuous improvements in process efficiency. Selling and administrative expenses for the Uniform Rental and Facility Services reportable operating segment increased$50.1 million in fiscal 2020 compared to fiscal 2019. Selling and administrative expense as a percent of revenue for fiscal 2020 was 28.1% compared to 27.6% in fiscal 2019. The increase in selling and administrative expenses as a percent of revenue was due to increases in labor and other employee-partner related expenses as well as impacts caused by COVID-19. In the fourth quarter of fiscal 2020, the Uniform Rental and Facility Services reportable operating segment initiated certain activities to reduce operating costs and better align its workforce with the needs of its ongoing business. During the fourth quarter of fiscal 2020, the reportable operating segment recorded$20.2 million in employee termination costs and$9.2 million in long-lived asset impairment costs. Due to the constantly changing impact of COVID-19, it is uncertain if similar additional activities will be initiated in the future. The Uniform Rental and Facility Services reportable operating segment incurred$14.4 million of integration expenses directly related to the G&K acquisition in fiscal 2019, which consisted primarily of facility closure expenses. There were no such expenses incurred in fiscal 2020. Income before income taxes increased$27.8 million to$1,004.6 million for fiscal 2020 compared to fiscal 2019. Income before income taxes as a percent of revenue at 17.8% increased 20 basis points from 17.6% in fiscal 2019. The increase was primarily due to the increase in gross margin, which was partially offset by the previously discussed impacts of COVID-19.
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First Aid and Safety Services Reportable Operating Segment First Aid and Safety Services reportable operating segment revenue increased$89.1 million in fiscal 2020, a 14.4% increase compared to fiscal 2019. Revenue increased organically by 14.8% as a result of new business and sales productivity increases, penetration of additional products and services into existing customers and sales of personal protective equipment in response to COVID-19. Revenue growth was negatively impacted by 0.4% due to one less workday in fiscal 2020 compared to fiscal 2019. Cost of sales for the First Aid and Safety Services reportable operating segment increased$47.5 million , or 14.7%, in fiscal 2020, primarily due to higher sales volume. Gross margin for the First Aid and Safety Services reportable operating segment is defined as revenue less cost of goods, warehouse expenses, service expenses and training expenses. The gross margin as a percent of revenue was 47.8% for fiscal 2020 compared to 48.0% in fiscal 2019. The decrease was primarily driven by an increase in the proportion of sales of personal protective equipment as a result of the impact of COVID-19. Selling and administrative expenses for the First Aid and Safety Services reportable operating segment increased by$24.8 million , or 12.0%, in fiscal 2020 compared to fiscal 2019 due to increased labor and other employee-partner related expenses. Selling and administrative expenses as a percent of revenue were 32.7% in fiscal 2020 compared to 33.4% in fiscal 2019. The decrease in selling and administrative expenses as a percent of revenue was due to revenue growing at a faster pace than labor and employee-partner related expenses.
Income before income taxes for the First Aid and Safety Services reportable
operating segment was
Liquidity and Capital Resources The following table summarizes our cash flows and cash and cash equivalents as of and for the fiscal years endedMay 31 : (In thousands) 2020 2019
Net cash provided by operating activities
Cash and cash equivalents at end of year
Cash and cash equivalents as of
Cash flows provided by operating activities have historically supplied us with a significant source of liquidity. We generally use these cash flows to fund most, if not all, of our operations and expansion activities and dividends on our common stock. We may also use cash flows provided by operating activities, as well as proceeds from long-term debt and short-term borrowings, to fund growth and expansion opportunities, as well as other cash requirements such as the repurchase of our common stock and payment of long-term debt. The disruption from COVID-19 negatively impacted Cintas' fiscal 2020 fourth quarter financial results, however, net cash flow provided by operating activities in the fourth quarter was not significantly impacted. AtMay 31, 2020 , our short-term liquidity position remained solid, as our cash flows from operating activities are expected to remain sufficient to provide us with adequate levels of short-term liquidity. In addition, we have access to$1.0 billion of short-term debt from our revolving credit facility. However, our long-term liquidity position remains unclear due to the constantly changing scope and nature of the impacts of COVID-19. Accordingly, we have taken proactive measures to maintain financial flexibility within the landscape of the COVID-19 pandemic. We believe the Company has sufficient liquidity to operate in the current business environment as a result of these actions. In order to preserve cash during this time of uncertainty, we plan to limit/reduce capital expenditures to essential business needs. Also, we will limit share buybacks until we obtain more certainty regarding the impacts of COVID-19. Acquisitions and dividends remain strategic objectives, however, they will be dependent on the economic outlook and liquidity of the Company.
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Net cash provided by operating activities was$1.3 billion for fiscal 2020, which was an increase of$223.6 million compared to fiscal 2019. The increase was primarily the result of favorable changes in working capital, specifically accounts receivable and inventories. Net cash used in investing activities was$285.4 million in fiscal 2020 compared to$235.6 million in fiscal 2019. Net cash used in investing activities includes capital expenditures, purchases of investments, proceeds from the sale of assets, cost method investments and businesses and cash paid for acquisitions of businesses. Capital expenditures were$230.3 million and$276.7 million for fiscal 2020 and fiscal 2019, respectively. Capital expenditures for fiscal 2020 included$183.4 million for the Uniform Rental and Facility Services reportable operating segment and$35.7 million for the First Aid and Safety Services reportable operating segment. Cash paid for acquisitions of businesses, net of cash acquired, was$53.7 million and$9.8 million for fiscal 2020 and fiscal 2019, respectively. The acquisitions in both fiscal 2020 and 2019 occurred in our Uniform Rental and Facility Services reportable operating segment, our First Aid and Safety Services reportable operating segment and our Fire Protection operating segment, which is included in All Other. In fiscal 2020, investing activities included proceeds of$13.3 million from the sale of assets, and in fiscal 2019, included proceeds of$73.3 million from the sale of a cost method investment and$3.2 million from the sale of a business included in discontinued operations. Net cash used in investing activities also included$10.0 million and$17.8 million of investment purchases during fiscal 2020 and fiscal 2019, respectively. Net cash used in financing activities was$955.2 million for fiscal 2020, compared to$873.3 million in fiscal 2019. The increase in cash used from financing activities from fiscal 2019 is primarily due to the payment of the$312.5 million of debt in fiscal 2020 versus issuance of$312.5 million of debt in fiscal 2019, partially offset by a decrease in cash used to repurchase common stock. OnAugust 2, 2016 , we announced that the Board of Directors authorized a$500.0 million share buyback program. This program was completed inNovember 2018 . OnOctober 30, 2018 , we announced that the Board of Directors authorized a$1.0 billion share buyback program, which does not have an expiration date. OnOctober 29, 2019 , we announced the Board of Directors authorized a new$1.0 billion share buyback program, which does not have an expiration date. The following table summarizes the buyback activity by program and fiscal year endedMay 31 : 2020 2019 Buyback Program (In thousands except per Avg. Price Avg. Price share data) Shares per Share Purchase Price Shares per Share Purchase Price August 2, 2016 - $ - $ - 2,130$ 192.55 $ 410,003 October 30, 2018 1,607$ 246.19 $ 395,681 2,673$ 203.30 $ 543,442 October 29, 2019 - $ - $ - - $ - $ - 1,607$ 246.19 $ 395,681 4,803$ 198.53 $ 953,445 There were no share buybacks in the period subsequent toMay 31, 2020 throughJuly 29, 2020 , under any share buyback program. From the inception of theOctober 30, 2018 share buyback program throughJuly 29, 2020 , Cintas has purchased a total of 4.3 million shares of Cintas common stock at an average price of$219.42 for a total purchase price of$939.1 million . In addition, for the fiscal year endedMay 31, 2020 , Cintas acquired 0.3 million shares of Cintas common stock in satisfaction of employee payroll taxes due on restricted stock awards that vested during the fiscal year. These shares were acquired at an average price of$260.89 per share for a total purchase price of$68.8 million . For the fiscal year endedMay 31, 2019 , Cintas acquired 0.3 million shares of Cintas common stock in satisfaction of employee payroll taxes due on restricted awards that vested during the fiscal year. These shares were acquired at an average price of 204.50 per share for a total purchase price of$62.9 million . OnOctober 29, 2019 , Cintas declared an annual cash dividend of$2.55 per share on outstanding common stock, a 24.4% increase over the annual dividend paid in the prior year. The dividend was paid onDecember 6, 2019 , to shareholders of record as ofNovember 8, 2019 . This marked the 37th consecutive year that Cintas has increased its annual dividend, every year since going public in 1983. During the fiscal year endedMay 31, 2020 , Cintas paid a net total of$112.5 million on commercial paper borrowings and paid off the term loan balance of$200.0 million with cash on hand. During the fiscal year endedMay 31, 2019 , Cintas issued$112.5 million , net of commercial paper borrowings and received proceeds of$200.0 million as a result of a new term loan.
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The following table summarizes Cintas' outstanding debt at
Interest Fiscal Year Fiscal Year (In thousands) Rate Issued Maturity 2020 2019 Debt due within one year Commercial paper 2.68 % (1) 2019 2020 $ -$ 112,500 Term loan 3.06 % (1) 2019 2020 - 200,000 Debt issuance costs - (236) Total debt due within one year $ -$ 312,264 Debt due after one year Senior notes 4.30 % 2012 2022$ 250,000 $ 250,000 Senior notes 2.90 % 2017 2022 650,000 650,000 Senior notes 3.25 % 2013 2023 300,000 300,000 Senior notes (2) 2.78 % 2013 2023 51,250 51,684 Senior notes (3) 3.11 % 2015 2025 51,637 51,973 Senior notes 3.70 % 2017 2027 1,000,000 1,000,000 Senior notes 6.15 % 2007 2037 250,000 250,000 Debt issuance costs (13,182) (16,150) Total debt due after one year$ 2,539,705 $ 2,537,507
(1) Variable rate debt instrument. The rate presented is the variable borrowing
rate at
(2) Cintas assumed these senior notes with the acquisition of G&K in the fourth quarter of fiscal 2017, and they were recorded at fair value. The interest rate shown above is the effective interest rate. The principal amount of these notes is$50.0 million with a stated interest rate of 3.73%. (3) Cintas assumed these senior notes with the acquisition of G&K in the fourth quarter of fiscal 2017, and they were recorded at fair value. The interest rate shown above is the effective interest rate. The principal amount of these notes is$50.0 million with a stated interest rate of 3.88%. The credit agreement that supports our commercial paper program was amended and restated onMay 24, 2019 . The amendment increased the capacity of the revolving credit facility from$600.0 million to$1.0 billion and created a new term loan of$200.0 million . The credit agreement has an accordion feature that provides Cintas the ability to request increases to the borrowing commitments under either the revolving credit facility or the term loan of up to$250.0 million in the aggregate, subject to customary conditions. The maturity date of the revolving credit facility isMay 23, 2024 , and the maturity date of the term loan wasMay 23, 2020 . As ofMay 31, 2020 , there was no commercial paper outstanding and no borrowings on our credit facility. As ofMay 31, 2019 , there was$112.5 million of commercial paper outstanding with a weighted average interest rate of 2.7% and maturity dates less than 30 days and no borrowings on our revolving credit facility. Cintas has certain covenants related to debt agreements. These covenants limit Cintas' ability to incur certain liens, to engage in sale-leaseback transactions and to merge, consolidate or sell all or substantially all of Cintas' assets. These covenants also require Cintas to maintain certain debt to consolidated earnings before interest, taxes, depreciation and amortization (EBITDA) and interest coverage ratios. Cross-default provisions exist between certain debt instruments. If a default of a significant covenant were to occur, the default could result in an acceleration of the maturity of the indebtedness, impair liquidity and limit the ability to raise future capital. Cintas was in compliance with all of the debt covenants for all periods presented. Our access to the commercial paper and long-term debt markets has historically provided us with sources of liquidity. We do not anticipate having difficulty in obtaining financing from those markets in the future in view of our favorable experiences in the debt markets in the recent past. However, the COVID-19 pandemic, which has caused disruption in the capital markets, could make financing more difficult and/or expensive. Additionally, our ability to continue to access the commercial paper and long-term debt markets on favorable interest rate and other terms will depend, to a significant degree, on the ratings assigned by the credit rating agencies to our indebtedness.
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As of
Rating Agency Outlook Commercial Paper Long-term Debt Standard & Poor's Negative A-2 A- Moody's Investors Service Stable P-2 A3 Standard and Poor's change in outlook from stable to negative reflects the inherent uncertainty regarding the spread of COVID-19 and the potential impact to Cintas' operating conditions, which could result in Cintas being unable to maintain adjusted leverage of less than two times total debt to EBITDA. In the event that the ratings of our commercial paper or our outstanding long-term debt issues were substantially lowered or withdrawn for any reason, or if the ratings assigned to any new issue of long-term debt securities were significantly lower than those noted above, particularly if we no longer had investment grade ratings, our ability to access the debt markets may be adversely affected. In addition, in such a case, our cost of funds for new issues of commercial paper and long-term debt would be higher than our cost of funds would have been had the ratings of those new issues been at or above the level of the ratings noted above. The rating agency ratings are not recommendations to buy, sell or hold our commercial paper or debt securities. Each rating may be subject to revision or withdrawal at any time by the assigning rating organization and should be evaluated independently of any other rating. Moreover, each credit rating is specific to the security to which it applies. To monitor our credit rating and our capacity for long-term financing, we consider various qualitative and quantitative factors. One such factor is the ratio of our total debt to EBITDA. For the purpose of this calculation, debt is defined as the sum of short-term borrowings, long-term debt due within one year, long-term debt and standby letters of credit. We have assessed the impact of events subsequent to our balance sheet date but prior to the issuance of this filing. The impact from COVID-19, however, continues to evolve, and the scope and nature of the impacts of COVID-19 remain unclear. As such, our conclusions regarding both our short-term and long-term liquidity position remain unchanged. Management will continue to evaluate the Company's liquidity position and our near- and longer-term financial performance as we manage the Company through the uncertainty related to COVID-19. Financial and Nonfinancial Disclosure About Issuers and Guarantors of Cintas' Senior Notes As discussed in Note 7 entitled Debt and Derivatives of " Notes to Consolidated Financial Statements ,"Cintas Corporation No. 2 (Corp. 2) is the indirectly, wholly owned principal operating subsidiary ofCintas. Corp. 2 is the issuer of the$2,550.0 million aggregate principal amount of senior notes outstanding as ofMay 31, 2020 , which are unconditionally guaranteed, jointly and severally, byCintas Corporation and its wholly owned, direct and indirect domestic subsidiaries. Basis of Preparation of the Summarized Financial Information The following tables include summarized financial information ofCintas Corporation (Issuer), Corp. 2 and subsidiary guarantors (together, theObligor Group ). Investments in and equity in the earnings of non-guarantors, which are not members of theObligor Group , have been excluded. Non-guarantor subsidiaries are located outside theU.S. , and therefore, excluded from theObligor Group . The summarized financial information of theObligor Group is presented on a combined basis with intercompany balances and transactions between entities in theObligor Group eliminated.The Obligor Group's amounts due from, amounts due to and transactions with non-guarantors have been presented in separate line items, if they are material. Summarized financial information of theObligor Group is as follows: Summarized Consolidated Statement of Income for the Year EndedMay 31, 2020 (In thousands)
Net sales to unrelated parties$ 6,642,196 Net sales to non-guarantors $ 4,778 Operating income$ 1,140,318 Net income$ 860,022 24
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Summarized Consolidated Balance Sheet as of
Obligor
Group
Assets
Receivables due from non-obligor subsidiaries$ 3,199 Total other current assets$ 2,143,489 Total other noncurrent assets$ 4,938,093
Liabilities
Amounts due to non-obligor subsidiaries$ 3,437 Current liabilities$ 843,203 Noncurrent liabilities$ 3,495,956 Contractual Obligations Payments Due by Period One year Two to Four to After five (In thousands) Total or less three years five years years Debt (1)$ 2,550,000 $ -$ 1,250,000 $ 50,000 $ 1,250,000 Operating leases (2) 178,131 46,765 68,226 34,725 28,415 Interest payments 606,183 95,530 151,210 108,630 250,813 Unconditional purchase obligations (3) 117,571 117,571 - - -
Total contractual cash obligations
(1)See Note 7 entitled Debt and Derivatives of " Notes to Consolidated Financial Statements " for a detailed presentation of Cintas' debt. (2)See Note 8 entitled Leases of " Notes to Consolidated financial Statements " for a detailed presentation of Cintas' leases. (3)Commitments entered into with key suppliers for minimum purchases quantities related to inventory needs in response to COVID-19. Cintas also makes payments to defined contribution plans and may make payments to defined benefit plans to satisfy minimum funding requirements. The amount of contributions made to the defined contribution plans are at the discretion of the Board of Directors of Cintas. Future contributions to the defined contribution plans are expected to be$70.2 million in the next year,$151.2 million in the next two to three years and$166.7 million in the next four to five years. Future contributions to the defined benefit plans are expected to be$4.8 million in the next year,$6.2 million in the next two to three years and$6.2 million in the next four to five years. Other Commitments Amount of
Commitment Expiration per Period
One year Two to Four to After five (In thousands) Total or less three years five years years Lines of credit (1)$ 999,877 $ -
$ -
120,634 118,831 1,803 - - Total other commitments$ 1,120,511 $ 118,831
(1)Back-up facility for the commercial paper program (reference Note 7 entitled Debt and Derivatives of " Notes to Consolidated Financial Statements " for further discussion). (2)These standby letters of credit and surety bonds support certain outstanding debt (reference Note 7 entitled Debt and Derivatives of " Notes to Consolidated Financial Statements "), self-insured workers' compensation and general liability insurance programs. Inflation and Changing Prices Changes in wages, benefits and energy costs have the potential to materially impact Cintas' consolidated results of operations. Management believes inflation has not had a material impact on Cintas' consolidated financial condition or a negative impact on the consolidated results of operations.
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Litigation and Other Contingencies Cintas is subject to legal proceedings, insurance receipts, legal settlements and claims arising from the ordinary course of its business, including personal injury, customer contract, environmental and employment claims. In the opinion of management, the aggregate liability, if any, with respect to such ordinary course of business actions will not have a material adverse effect on the consolidated financial position, consolidated results of operations or consolidated cash flows of Cintas. The Company and three executive officers were defendants in a purported class action, filed onDecember 12, 2019 , pending in theU.S. District Court for the Southern District of Ohio alleging violations of federal securities laws. The lawsuit asserted that the defendants made material misstatements regarding the Company's margins, earnings guidance and regulatory compliance that caused the Company's stock to trade at artificially inflated prices betweenMarch 2017 andNovember 2019 . The lawsuit was dismissed without prejudice onApril 22, 2020 . The Company, the Board of Directors, CEO and theInvestment Policy Committee are defendants in a purported class action, filed onDecember 13, 2019 , pending in theU.S. District Court for the Southern District of Ohio alleging violations of ERISA. The lawsuit asserts that the defendants improperly managed the costs of the employee retirement plan, breached their fiduciary duties in failing to investigate and select lower cost alternative funds and failed to monitor and control the employee retirement plan's recordkeeping costs. The defendants deny liability. New Accounting Standards InFebruary 2016 , theFinancial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2016-02, "Leases (Topic 842)," as amended. Cintas adopted this standard effectiveJune 1, 2019 , using a modified retrospective transition approach. Topic 842 requires lessees to apply a dual approach, classifying leases as either finance or operating leases based on the principle of whether or not the lease is effectively a financed purchase by the lessee. This classification will determine whether lease expense is recognized based on an effective interest method or on a straight-line basis over the term of the lease. A lessee is also required to record a right-of-use asset and a lease liability for all leases with a term of greater than 12 months regardless of their classification. Topic 842 provided a number of optional practical expedients in transition, and we have determined to use certain of these practical expedients upon our adoption of Topic 842. Specifically, the Company elected the package of practical expedients permitted under Topic 842, which allows a lessee to carryforward their population of existing leases, the classification of each lease, as well as the treatment of initial direct lease costs as of the period of adoption. The Company also elected the practical expedient related to lease and non-lease components, as an accounting policy election for the fleet and vehicle asset class, which allows a lessee to not separate non-lease from lease components and instead account for consideration paid in a contract as a single lease component. In addition, the Company elected the short-term lease recognition exemption for all leases with a term of 12 months or less, which means it will not recognize right-of-use assets or lease liabilities for these leases. The adoption of Topic 842, onJune 1, 2019 , resulted in the Company recognizing right-of-use assets, net of$168.0 million and corresponding lease liabilities of$173.4 million . The adoption of Topic 842 did not have a material impact on the Company's consolidated statements of income or consolidated statements of cash flows. InFebruary 2018 , the FASB issued ASU 2018-02, "Income Statement - Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income." This standard allows entities to elect to reclassify the income tax effects of the Tax Cuts and Jobs Act (Tax Act) on items within accumulated other comprehensive income to retained earnings. EffectiveJune 1, 2019 , Cintas adopted ASU 2018-02, on a prospective basis, which resulted in a$2.0 million reclassification adjustment of the stranded tax effects from retained earnings to accumulated other comprehensive loss that was determined using a specific identification method. InApril 2019 , the FASB issued ASU 2016-13, "Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments." ASU 2016-13 will replace the incurred loss impairment methodology with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates. In connection with recognizing credit losses on accounts receivable and other financial instruments, Cintas will be required to use a forward-looking expected loss model rather than the incurred loss model. ASU 2016-13 is effective for annual periods beginning afterDecember 15, 2019 , with early adoption permitted. The adoption of this standard will be through a cumulative-effect adjustment to retained earnings as of the effective date. Cintas will adopt this standard onJune 1, 2020 , and the adoption of this standard is not expected to have a material impact on the consolidated financial statements.
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InJanuary 2017 , the FASB issued ASU 2017-04, "Simplifying the Test forGoodwill Impairment." ASU 2017-04 eliminates the two-step process that required identification of potential impairment and a separate measure of the actual impairment.Goodwill impairment charges, if any, would be determined by the difference between a reporting unit's carrying value and its fair value (impairment loss is limited to the carrying value). This standard was adopted by Cintas in the current fiscal year and did not have a material impact on the consolidated financial statements. InMay 2014 , the FASB issued ASU 2014-09, "Revenue from Contracts with Customers (Topic 606)," to clarify revenue recognition principles. This guidance is intended to improve disclosure requirements and enhance the comparability of revenue recognition practices. Improved disclosures under the amended guidance relate to the nature, amount, timing and uncertainty of revenue that is recognized from contracts with customers. We adopted ASU 2014-09, and all the related amendments, effectiveJune 1, 2018 using the modified retrospective method. ASU 2014-09 requires a company to recognize revenue to depict the transfer of goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. Upon adoption of ASU 2014-09, we recorded an adjustment to the opening balance of retained earnings as ofJune 1, 2018 . The adjustment to retained earnings primarily relates to the capitalization of certain direct and incremental contract costs required by the new guidance. Capitalized costs are amortized ratably over the anticipated period of benefit. We applied ASU 2014-09 only to contracts that were not completed prior to fiscal 2019. The adoption of ASU 2014-09 did not have a material impact on our consolidated statements of comprehensive income and had no impact to the Company's operating cash flow. InMarch 2020 , theSEC amended Rule 3-10 of Regulation S-X regarding financial disclosure requirements for registered debt offerings involving subsidiaries as either issuers or guarantors and affiliates whose securities are pledged as collateral. This new guidance narrows the circumstances that require separate financial statements of subsidiary issuers and guarantors and streamlines the alternative disclosure required in lieu of those statements. We adopted these amendments for the year endedMay 31, 2020 . Accordingly, combined summarized financial information has been presented only for the issuer and guarantors of our senior notes for the most recent fiscal year and the year-to-date interim period, and the location of the required disclosures has been removed from the notes to the consolidated financial statements and moved to Part II. Item 7.
Management's Discussion and Analysis of Financial Condition and Results of Operations .
No other new accounting pronouncement recently issued or newly effective had or is expected to have a material impact on the consolidated financial statements.
Critical Accounting Policies and Estimates The preparation of Cintas' consolidated financial statements in conformity withU.S. GAAP requires management to make estimates and judgments that have a significant effect on the amounts reported in the consolidated financial statements and accompanying notes. These critical accounting policies should be read in conjunction with Note 1 entitled Significant Accounting Policies of " Notes to Consolidated Financial Statements ." Significant changes, estimates or assumptions related to any of the following critical accounting policies, including those impacted by COVID-19, could possibly have a material impact on the consolidated financial statements. Revenue recognition Rental revenue, which is recorded in the Uniform Rental and Facility Services reportable operating segment, is recognized when services are performed. Other revenue, which is recorded in the First Aid and Safety Services reportable operating segments and All Other, is recognized when either services are performed or the obligations under the terms of a contract with a customer are satisfied. See Note 2 entitled Revenue Recognition of the " Notes to Consolidated Financial Statements " for more information on Cintas' revenue. Uniforms and other rental items in service Uniforms and other rental items in service are valued at cost less amortization, calculated using the straight-line method. Uniforms in service (other than cleanroom and flame resistant clothing) are amortized over their useful life of 18 months. Other rental items, including shop towels, mats, mops, cleanroom garments, flame resistant clothing, linens and restroom dispensers, are amortized over their useful lives, which range from 8 to 60 months. The amortization rates used are based on industry experience, Cintas' specific experience and wear tests performed by Cintas. These factors are critical to determining the amount of in service inventory and related cost of uniforms and ancillary products that are presented in the consolidated financial statements.
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Property and equipment Depreciation is calculated using the straight-line method over the estimated useful lives of the assets based on industry and Cintas specific experience, which is typically 30 to 40 years for buildings, 5 to 20 years for building improvements, 3 to 10 years for equipment and 2 to 15 years for leasehold improvements. When events or circumstances indicate that the carrying amount of long-lived assets may not be recoverable, the estimated undiscounted future cash flows are compared to the carrying amount of the assets. If the estimated undiscounted future cash flows are less than the carrying amount of the assets, an impairment loss is recorded based on the excess of the carrying amount of the assets over their respective fair values. Fair value is generally determined by discounted cash flows or based on prices of similar assets, as appropriate. As a result of certain restructuring activities to eliminate excess capacity and reduce our cost structure, an indicator of potential impairment was identified. Cintas recognized an impairment loss of$9.2 million during the year endedMay 31, 2020 , based on the excess of the carrying amount of assets over their respective fair values. The undiscounted cash flows were estimated, using Level 2 inputs based on both the cost and market approaches, at the lowest discernible level of cash flows, which is at the location level. Cintas did not identify any indicators of impairment for the fiscal years endedMay 31, 2019 and 2018.
Goodwill , obtained through acquisitions of businesses, is valued at cost less any impairment. Cintas completes an annual impairment test, that includes an assessment of qualitative factors including, but not limited to, macroeconomic, industry and market conditions, and entity specific factors such as strategies and financial performance. In fiscal 2020, we identified the impact from COVID-19 as a qualitative factor that necessitated a quantitative analysis. We test for goodwill impairment at the reporting unit level. Cintas has identified four reporting units for purposes of evaluating goodwill impairment: Uniform Rental and Facility Services, First Aid and Safety Services and two reporting units within All Other. To test for goodwill impairment, using a quantitative analysis, we estimate the fair value of each of our reporting units using both a discounted cash flow valuation technique and a market-based approach. The impairment test is dependent upon a number of significant estimates and assumptions, including macroeconomic conditions, growth rates, competitive activities, cost containment, margin expansion and our business plans. We believe these estimates and assumptions are reasonable. However, future changes in the judgments, assumptions and estimates that are used in our impairment testing for goodwill and identifiable intangible assets, including discount and tax rates or future cash flow projections, could result in significantly different estimates of the fair values. The most significant assumptions used in the determination of the estimated fair value of the reporting units are the revenue and EBITDA growth rates (including terminal growth rates) and the discount rate. The terminal growth rate represents the rate at which the reporting unit is expected to grow beyond the shorter-term business planning period. The terminal growth rate utilized in our fair value estimate is consistent with the reporting unit operating plans and approximates expected long-term category market growth rates and inflation. The discount rate, which is consistent with a weighted average cost of capital that is likely to be expected by a market participant, is based upon industry required rates of return, including consideration of both debt and equity components of the capital structure. The discount rates may be impacted by adverse changes in the macroeconomic environment, specifically the COVID-19 pandemic, volatility in the equity and debt markets or other factors. Based on the results of the annual impairment tests, Cintas was not required to recognize an impairment of goodwill for the fiscal years endedMay 31, 2020 , 2019 or 2018. Cintas will continue to perform impairment tests as ofMarch 1 in future years and when indicators of impairment exist. Service contracts and other assets Service contracts and other assets, which consist primarily of noncompete and consulting agreements obtained through acquisitions of businesses, are amortized by use of the straight-line method over the estimated lives of the agreements, which are generally 5 to 10 years. The G&K service contract asset is being amortized over a period of 15 years, which represents the estimated life of the economic benefit and the asset amortization is based on the annual economic value of the underlying asset, which generally decreases over the 15-year term. Certain noncompete agreements, as well as all service contracts, require that a valuation be determined using a discounted cash flow model. The assumptions and judgments used in these models involve estimates of cash flows and discount rates, among other factors. Because of the assumptions used to value these intangible assets, actual results over time could vary from original estimates. Impairment of service contracts and other assets is accomplished through specific identification. No impairment has been recognized by Cintas for the fiscal years endedMay 31, 2020 , 2019 or 2018.
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Insurance reserve The insurance reserve represents the estimated ultimate cost of all asserted and unasserted claims, primarily related to workers' compensation, auto liability and other general liability exposure through the consolidated balance sheet dates. Our reserves are estimated through actuarial procedures, with the assistance of third-party actuarial specialists, of the insurance industry and by using industry assumptions, adjusted for specific expectations based on our claims history. Cintas records an increase or decrease in selling and administrative expenses related to development of prior claims, higher claims activity and other environmental factors in the period in which it becomes known. These changes in estimates may be material to the consolidated financial statements. Stock-based compensation Compensation expense is recognized for all share-based payments to employees, including stock options and restricted stock awards, in the consolidated statements of income based on the fair value of the awards that are granted. The fair value of stock options is estimated at the date of grant using the Black-Scholes option-pricing model. Generally, measured compensation cost, net of estimated forfeitures, is recognized on a straight-line basis over the vesting period of the related share-based compensation award. See Note 12 entitled Stock-Based Compensation of " Notes to Consolidated Financial Statements " for further information. Litigation and other contingencies Cintas is subject to legal proceedings and claims arising from the ordinary course of its business, including personal injury, customer contract, environmental and employment claims.U.S. GAAP requires that a liability for contingencies be recorded when it is probable that a liability has occurred and the amount of the liability can be reasonably estimated. Significant judgment is required to determine the existence of a liability, as well as the amount to be recorded. While a significant change in assumptions and judgments could have a material impact on the amounts recorded for contingent liabilities, Cintas does not believe that they will result in a material adverse effect on the consolidated financial statements. Income taxes Deferred tax assets and liabilities are determined by the differences between the consolidated financial statement carrying amounts and the tax basis of assets and liabilities. Therefore, the Company has not recorded deferred taxes for basis differences expected to reverse in future periods. Cintas accounts for Global Intangible Low-Taxed Income (GILTI) as a current-period expense when incurred. See Note 9 entitled Income Taxes of " Notes to Consolidated Financial Statements " for the types of items that give rise to significant deferred income tax assets and liabilities. Deferred income taxes are classified as assets or liabilities based on the classification of the related asset or liability for financial reporting purposes. Cintas regularly reviews deferred tax assets for recoverability based upon projected future taxable income and the expected timing of the reversals of existing temporary differences. Although realization is not assured, management believes it is more likely than not that the recorded deferred tax assets, as adjusted for valuation allowances, will be realized. Accounting for uncertain tax positions requires the determination of whether tax benefits claimed or expected to be claimed on a tax return should be recorded in the consolidated financial statements. Companies may recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the consolidated financial statements from such a position should be measured based on the largest benefit that has a greater than fifty percent likelihood of being realized upon ultimate settlement. Cintas is periodically reviewed by domestic and foreign tax authorities regarding the amount of taxes due. These reviews include questions regarding the timing and amount of deductions and the allocation of income among various tax jurisdictions. In evaluating the exposure associated with various filing positions, Cintas records reserves as deemed appropriate. Based on Cintas' evaluation of current tax positions, Cintas believes its tax related accruals are appropriate. 29
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